Understanding Technical Indicators used in Commodity Trading

Commodity trading differs significantly from trading stocks and bonds due to the nature of commodities and the various environmental and economic factors that impact their values. Technical analysis plays a pivotal role in predicting commodity price trends, guiding beginners and advanced traders alike in making prudent investment decisions. Among the plethora of strategies and tools available for technical analysis, some established indicators have proven exceptionally reliable in commodity trading. This article takes a comprehensive look at these indicators—from moving averages to the relative strength index—and offers a detailed explanation of their functions.

Moving Averages

Moving averages are arguably the most common indicator among commodity traders. The concept is straightforward; it calculates the average price over a specified period. The two principal types are the simple moving average (SMA) and the exponential moving average (EMA). The SMA calculates the average of a chosen range of prices, typically closing prices, over a set number of days. The EMA, unlike the SMA, places more weight on recent price moves, making it more responsive to new trends.

By comparing shorter-term moving averages (like the 10-day average) to longer-term ones (such as the 50-day average), traders can spot trend reversals—a principal trading signal. For example, a crossover of the short-term moving average from below to above the long-term average may suggest a bullish trend.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. It gives traders a sense of whether a commodity is overbought or oversold. The RSI ranges from 0 to 100; typically, a commodity with an RSI above 70 is considered overbought, meaning it could be overpriced and due for a price correction or a bearish revolt. Conversely, if the RSI falls below 30, the commodity is seen as oversold and hence might be undervalued, potentially leading to a price bounce or a bullish trend.

Stochastic Oscillator

The Stochastic Oscillator, like the RSI, is a momentum indicator that compares a specific closing price of a commodity to a range of its prices over a certain time period. The theory behind the stochastic oscillator is that in a market uptrend, prices tend to close near their high, and during a market downtrend, prices close near their low. The stochastic oscillator is calculated using the following formula: %K = 100(C – L14)/(H14 – L14), where C is the most recent closing price, L14 is the lowest price traded of the 14 previous trading sessions, and H14 is the highest price traded during the same 14-day period. The ‘%K’ is then smoothed with a 3-day simple moving average, which is the ‘slow’ stochastic oscillator.

Bollinger Bands

John Bollinger created Bollinger Bands in the 1980s, which are a statistical chart that depicts the prices and volatility of a commodity over time. They consist of a simple moving average (SMA) and two standard deviations charted as one line above and one below the SMA. The band will expand and contract as volatility increases or decreases. Prices are relatively high when they touch the upper band and relatively low when they hit the lower band.

MACD – Moving Average Convergence Divergence

The Moving Average Convergence/Divergence (MACD) is a trend-following momentum indicator showing the relationship between two moving averages of a commodity’s price, calculated using three time-period moving averages. By subtracting the 26-day exponential moving average (EMA) from the 12-day EMA, the MACD line is created. A nine-day EMA of the MACD, the “signal line,” is plotted on top of the MACD line, providing a trigger for buy and sell signals.

Pivot Points

The calculation of the average of significant prices (high, low, or close) from a market’s performance in the previous trading period is the basis for the technical analysis technique known as pivot point analysis. These points can be critical support and resistance zones for the next session and can be used for breakout and bounce strategies.

End Note

Technical indicators are indispensable tools in commodity trading, providing signals for entry and exit points, potential trend reversals, and price momentum. Their effective usage requires time and practice to understand how they function in various market conditions and commodity types. Whether you’re a beginner or an advanced trader, the proper application of these tools can enhance your decision-making process, mitigating risks and potentially yielding profitable returns in your commodity trading ventures. It is crucial to note, however, that while these indicators are helpful, they should be used in conjunction with other tools and strategies to increase the probability of successful trades.